Agenda

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Review

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The German Hyperinflation –Part 1

Microeconomics vs. MacroeconomicsQuantitative and precise Lots of theories to explain trends

Quantity Theory of MoneyMV = P(Q) (T), Assume M is constantDuring inflation V increases (so P increases) During deflation V decreases (so P decreases)

The German Hyperinflation –Part 2

How to Stop InflationFiscal Policy – Raise taxes, cut spendingMonetary Policy – Shrink money supply, raise interest rates (i)

How to Stop HyperinflationFiscal Policy and Monetary Policy don’t workNeed some symbolic gesture to restore confidence in currency

Random Note on InflationInflation is not bad or good, people just think it is bad

The Great Depression – Part 1

DeflationDeflation is badAlways wait to make a purchaseBy holding cash you decrease VReal interest rates and real value of debt increaseReal wages increase

Cause of DepressionBank failure – like runaway inflation has to do with a loss of confidence

Cure for DepressionMonetary policy does not work during deflation, the only way to battlepersistent deflation is through a massive fiscal stimulus – government spending is better than a tax cut

The Great Depression – Part 2

Make sure you know what each variable below means and

how it changes:

Y = C + I + G + (X-M)

Be aware of the multiplier and investment accelerator

The Reagan Plan

Phillips CurveTheory that inflation and unemployment are inversely related. Mostly

true, but in true macroeconomic fashion can’t explain everything

Crowding Out

S-I = (X-M) + (G-T) trade deficit gov’t budget deficit

If X-M = 0 and G-T = 0, you only invest what you save

If you run a trade deficit (X<M ), you can invest more than savings

If you run a gov’t deficit ( G>T ), you must invest less than savings

Singapore

ProductivityEasy way to measure: output/hours

Correct way to measure: output/index of inputs (cap., lab.,Natural Resources )

Complicated equation simplified: Output = KαLβ

a+b=1 constant returns to scaleJust think about capital intensive ( European Ski slopes ) or labor intensive ( agriculture in most countries )

Steps 1 and 2 in developing countries:1) Mobilize resources (capital or labor)2) Invest in skills and education

Chile – Part 1

Comparative AdvantageHow efficiently you produce one product compared to another product. Key point is that with CA trade almost always improves efficiency.

Exchange Rates

Factor in country A Change Effect on Country A’s currency Interest rate in A Increase Appreciate

Inflation rate in A Increase Depreciate

Demand for A’s goods Increase Appreciate

Country A output growth Increase Appreciate

Chile – Part 2

Solution for Chilean problem1) Privatize

2) De-Regulate

3) Run a budget surplus What are these two items?

4) Set up a Provident Fund

5) Free up trade

6) Free up exchange rate

Mexico – Part 1

What do you do when are running out of foreign exchange reserves?1) Let currency float

2) Raise interest rates to entice savings back in (reduces investment in ST)

3) Increase government budget surplus (gov’t is increasing capital supply)

4) Tight monetary policy (#2) and fiscal policy (#3) drive you into a recession,

you can’t afford imports, and you correct your balance of payments

Mexico – Part 2

Anatomy of a crisis1. Unsustainability (asset price bubble, BOP deficit, etc.)2. Cannot and will not last3. Time and Trigger unknown4. Insiders will run first5. Asset prices will fall6. Collateral melts because of #57. Good loans default because of #6 Æ banks call loans8. Banks will stop rolling over loans9. Supplier credit disappears10.Wealthy people will leave Æ value of currency decreasesÆreal debts increases Æ more firms default and go broke

Asian Crisis – Part 1

Exchange Rate SystemsLeast Flexible – DollarizationCurrency board Fixed exchange rate Crawling pegDirty flexible rateClean flexible rates

Depreciation = Market lowers value of currency

Devaluation = Government lowers value of currency that they were trying to hold fixed

Asian Crisis – Part 2

Strategy for Asian countriesJapan has highly skilled workforce and a lot of technologyChina has a huge, inexpensive labor force

Strategy #1- Go upscale and try to do technology (have to compete withJapan)

Strategy #2- Lower wages (have to compete with China)\

Strategy #1 probably trumps #2, China will force 3rd world countries to go forimport substitution

Argentina

Use as review case

Russia

Capitalism is hard to start (even in a developed country)1. Must go down before you go up2. Property rights must be set up (people usually get killed over this)3. Need a legal system and a system to enforce laws4. Need a tax system5. Need a banking system6. Need a social welfare system7. Need an accounting system8. Need infrastructure

When transitioning from communism, you need to generate both sides of a trade, since the government was always the buyer or seller before

China

What was their strategy1. Mobilized Labor

2. Focused on exports (Japanese model)

1. Foreign companies invest in China and export products to rest of

world (these guys make money)

2. Foreign companies invest in China and sell product in China (these

guys hope to build a brand and make money in 20+ years)

Random Notes1. Don’t always believe the #s, check the source and look for consistency in the data

2. Electricity grows @ 1.1X GDP

Uganda

Checklist for developing countries1. Mobilize resources2. Invest in skills (education)3. Invest in infrastructure4. Develop technology

Problem here is that before you can even do #1 you need to be organized

European Monetary Union

Free trade areas versus common marketsAll free trade areas collapse. Why?1. You get a crisis and it is easy to defect2. Leveling down3. Only goods move, not labor

EU common market:Works because participants were all roughly equal going in

Harmonization: Safety, taxes, health&environment, labor market

Current issue: widening vs. deepening

Try to apply lessons from EU to other trade zones and agreements

France – Unemployment – Part 1

3 Easy ways to reduce unemployment1. Set monetary and fiscal policy to stimulate demand2. Reduce the labor supply3. Lower wages

Thurow’s solutionCut payroll tax to zero (which of the above 3 ways is this?)Increase the VAT to make up the shortfall

Factor Price EqualizationCompanies move production facilities to achieve the lowest possible cost offactor inputsIf countries want the companies back then factor prices must adjust (e.g. wages decline)

France – Unemployment – Part 2

EU vs. US in terms of factor inputsEU is a capital intensive systemUS is a labor intensive system

Labor market flexibility (LMF)With limited LMF small companies cannot grow big (they can’t survive the inevitable downturns in the economy)

Role of unemployment1. Lower wages2. Forces people to move

Japan

Post WWII1. Mobilized capital2. Organized labor3. Purchased technology4. Strategy of follow the leader (US)5. Government controlled banking system directing investment6. Export-led model

Why can’t they clean up the current mess?Won’t admit failure, no rules for bankruptcy, don’t send people to jail,haven’t felt enough pain, bureaucracy, labor market inflexibility,fiscal stimulus too small (need massive) and no more monetary policy possible since i= 0

Globalization

Over time there will be no more corporate taxes, countries will start paying companies to locate there

Problem with globalizationRace to the bottom (similar to leveling down)

Issues with globalizationEnvironment Labor standards(child labor, safety,

etc.)Local culture HealthIntellectual Property Rights Income inequality

Random notessuperior vs. inferior goods, crisis of the common

Wage Inequality

Wage inequality comes with capitalism

Possible explanations for wage inequality1. Inheritance2. Hard to lose all of your wealth3. Winner takes all4. Bureaucracy5. Compounding of talents7. Luck

Why doesn’t the system collapse?People who have a lot of money give money back to those who don’t